One more time?
After several months over the summer, when it appeared that Covid was not the only thing investors and journalists could talk about, we are back to being amateur virologists. As the now named new Covid variant ‘Omicron’ takes hold of our thoughts, it is a reminder that the pandemic is not a problem with a defined end point.
More likely Covid is with us forever in different forms, but we learn how to live with it through vaccination programs and other types of medicines such as antivirals. We do not have any knowledge ourselves as to the path of Omicron over the next few weeks, but there are investment lessons from the last 18 months which are worth restating, should market volatility return.
Perhaps the key lesson of the initial pandemic panic of March 2020, and indeed every market panic, is that the short term has minimal importance with respect to the value of long duration assets, such as equities. As a simple rule of thumb, an equity trading on 20 times its current earnings has approximately 5% of its value (100% divided by 20) in the first of those 20 years (for a stock on 40 times, 2.5% etc). If the long-term prospects of a business are not impacted by a short-term event, most of its value will remain untouched. Even losing two years of profits would only result in a 10% decrease in value. This is something which is forgotten every time we have a recession or bear market creating event. It is the essence of the ‘buy the dip’ mantra which has served investors well for many decades. This rule of thumb can of course be influenced by long-term structural shifts in the economy and industries within it. There will be big winners (technology, healthcare) and big losers (airlines, oil) from the structural changes we see occurring right in front of us. Generally, though, investors significantly assign too much weight to current events in their thinking – to their detriment.
Another key lesson is the adaptability of the corporate sector, which is ultimately tied into the adaptability of humans. Eighteen months after the biggest event any company will have to face, the shutdown of the global economy, profit margins and overall profits are at record highs. Many companies have used this crisis to reengineer their business models, usually using technology, to make themselves more efficient and flexible, allowing them to make higher profits than before the pandemic, sometimes on lower revenues. Overall, the pandemic has improved the long-term prospects of the corporate world, despite there being winners and losers within this. Never waste a crisis, and the corporate sector certainly has not.
The final lesson we would refer to is the idea that the only risks that really matter in investing are the ones we don’t know about. This is the ‘if it’s in the paper it’s in the price’ rule. Whatever is in the consciousness of markets, whether that be pandemics, trade wars or inflation, is by definition at least to some degree discounted in prices. It is at the point when new risks first come onto the radar of markets that big moves can occur, not when an issue is widely talked about. The pandemic has had less impact on markets with each wave, as it has become better understood and more effectively discounted in prices. We will almost certainly be worrying about something new in a year from now, something that we aren’t currently comprehending. That is the way of markets.
Putting these three elements together, and we’ll be learning the lessons of the last 18 months (and the many years before) to see if we can use a recurrence of market volatility to add to some of our best placed businesses at more attractive prices. We think the companies we own are more valuable because of the pandemic and have adapted very well to the new environment they operate in. Although we continue to be worried about the pandemic as citizens, as investors we think it is largely priced in.
This has undoubtedly been one of the more volatile times in the history of our sustainable funds! Tracing the timeline back to March last year, perhaps only the financial crisis can rival it in terms of the scale and speed of market moves. Volatility is the friend of long-term investors, giving them the opportunity to buy more of what they like for less. However, living through it can be a challenge.
As of early December, our sustainable funds have had a strong 2021. This however masks periods of strong out and underperformance rather than a consistent trend. There are however some themes that are worth highlighting, as reasons why this year has been a good one:
- Value investing – despite many views to the contrary, this has not been the year when value investing finally made a comeback. Growth investing has once again beaten value. Indeed, taking the period since the start of 2020, and using the MSCI indices, this has been one of the worst periods for value investing in some time. There are several reasons for this. The primary one is the long-term prospects for those companies and industries badged as growth (technology, healthcare, engineering, chemistry) have accelerated due to the pandemic, and conversely those companies and industries badged as value (leisure, oil, retail etc) have seen their prospects worsen. Value vs growth is simply a manifestation of the underlying trends in the global economy, not purely a question of reversion to the mean or bond yields.
- Technology is booming – technology has been the one sector to not be short of in the last decade, and this has only accelerated in 2021. The technology sector is a beneficiary of most major trends, such as digitisation and inflation, that we see around us. The pandemic is taking the share of corporate expenditure on technology to new highs: we are all technology companies now. Most of the large technology companies trade on higher valuations than they did pre the pandemic, as their earnings have increased, and their long-term prospects have strengthened. Sure, there are always signs of froth in some technology investments, but companies such as Microsoft are still likely to be good investments in the future.
- Stock selection remains key – active investors will always be biased to defending their patches versus passive solutions. The truth is, there is a place for both. What we witness though currently is unprecedented levels of disruption at the individual company level, and significant risks/opportunities for those on the wrong/right side of them. This is not an environment conducive to broad exposure across industries, but one which requires defined choices to be made in how to invest. This is, in my view, how it should be. The difference of late is that the benefit of getting these choices correct have been higher than in the past, making the rewards greater for successful active managers.
Somewhere amid the failure of the value argument to win out, exposure to technology and good stock picking is the story of our 2021. There is still a month to go however, and as we all now know, anything can happen!
One last 2021 thought
What we have learnt and relearnt this year is that the primary determinants of successful investing are what you own, and how long you own it for. There are always worries, risks and events, but in my view good companies do well in good times, and even better in bad. Whatever 2022 brings, we believe that our focus on this, and our commitment to invest sustainably, will serve our investors well.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.